AIG is selling off its Japanese and Philippine insurance affiliates.  Rio Tinto and Anglo American are reconsidering global expansion plans in the mining industry.  Lafarge, the world's biggest cement producer, is scaling back international expansion and selling assets to reduce its debt ratio.  GSK, the world's second largest drug maker, is cutting its US operations.  BP is cutting 5000 jobs worldwide.

These are just some examples of the foreign direct investment (FDI) tsunami currently underway.

FDI has been perhaps the most dynamic aspect of globalization.  From 1980 to 1990, it quadrupled in value to over $200 billion, before easing back a little.  The next wave then peaked at $1400 billion in 2000.  It then crashed down to less than $600 billion in 2003.  A new wave came to an historic peak in 2007 of over $1800.  But now, with the global financial crisis, FDI is in free fall again.  On the basis of evidence to date, UNCTAD estimates FDI for 2008 at $1400 billion (a fall of more than 20%).  It will likely fall again in 2009.  

Nothing is untouched by this crisis.  A negative feedback loop between all aspects of the economy is dragging everything down.

The 2003-2007 FDI wave was driven by a strongly growing world economy, ongoing liberalisatin of FDI policies and the continued implementation of large-scale internatiionalisation strategies by a growing number of multinational enterprises (MNEs).  Developed countries accounted for $1250 billion of global inflows in 2007, while developing countries' share was $500 billion.  However, the nature of FDI differs between the two groups.  Inflows into developed countries were more than accounted for by cross-border mergers and acquisitions (M&As), whereas only 30% of inflows into developing countries were M&As -- greenfield investments accounted for the lion's share.

The initial effects of the financial crisis have been more noticable on developed countries, for which inflows dropped by one-third in 2008 -- much of that fall was concentrated in Europe, with flows to the US being little changed.  Inflows into developing countries were broadly stable.  The setback in FDI has particularly affected M&As -- there has been a rising wave of divestments and restructurings.  Although greenfield investments have been less affected to date, they may well be affected in 2009 as a large number of projects could be cancelled or postponed.

How does the crisis impact on FDI flows?  UNCTAD focusses on two factors, supply and demand (pain and passion).

Firms' capacity to invest is adversely affected by reduced availability of finance due to both the credit crunch and lower corporate profits.  The desire to invest is also adversely affected by the gloomy world economic prospects, and high level risks and uncertainties.  In its January 2009 paper, UNCTAD cites the IMF forecast for the world economy of 2.2% for 2009.  Since that time, the IMF has cut its forecast to 0.5%, and is already planning to cut it again.  Things have deteriorated in just this short time, and they are getting worse by the moment.

Where to next?

While the future looks gloomy, UNCTAD highlights a number of positive forces at work which could help maintain strong levels of FDI.  First, UNCTAD argues that emerging economies like the BRICs (Brazil, Russia, India and China) will remain attractive markets.  Second, financial crises and economic downturns offer opportunities to buy assets at bargain prices and to take advantage of industry restructuring and consolidation.  Third, MNEs are in general still committed to increasing their level of internationalisation in the medium term.  Fourth, new sources of FDI have arisen, most notably among emrging economies like China, which has invested massively in Africa and Latin America.  Fifth, many industries have promising prospects despite the crisis, industries like renewable energy to cite just one example.

UNCTA sketches out three scenarios of a V-, U- or L-shaped recovery.  If the past provides any guide to the future, it will be a V-shaped recovery, not the U-shaped recovery they consider the most probable.  But the V could be sharper and deeper than anyone imagines.  Given the imporance of M&As in global FDI, global FDI could drop to almost nothing in the very short term.  UNCTAD's estimate for 2008 may even be way too high -- it could be revised down.

The solid performance of FDI into developing countries in 2008 may just reflect lags.  The crisis started in the developed world.  In just the past two months, East Asia supply chains which feed the US and EU markets have seen bigs crashes in their exports.  Don't forget that East, South and South-East Asia account for half of all FDI to developing countries.  On top of this, the fall in oil and other commodity prices will surely affect FDI in the extractive industries.

At the end of every night there is a dawn.  Although we cannot see it yet, dawn will arrive, one day or another.  And it will be crucial that borders stay open to FDI (to date there has been no evidence of investment protectionism).  FDI will part of the crisis solution.  Foreign investors can through M&As facilitate the necessary corporate restructurings.  And when the time comes for governments to sell back their shares in financial institutions, foreign investors can also play an important role.

Reference

Assessing the impact of the current financial and economic crisis on global FDI flows, UNCTAD, January 2009 -- www.unctad.org